Software Licensing & Master Service Agreements : Chicago Software Licensing Lawyer & Attorney : Sam Conforti Law Firm : Master Service Agreements, Negotiations, Outsourcing : Cook County, Illinois

Last year, April 19, 2008, I posted an article entitled Is a Clickwrap Agreement Enforceable?. The article defined the terms and gave a general understanding of where we encounter these types of agreements. My editorial comment dealt with my “natural aversion” to the non-negotiability of such agreements. Based on the number of hits the article receives, it is easy to discern the interest in the topic and it seems appropriate at this time to augment the article with a “How To” approach. During the course of my research, a colleague of mine from my days at SAP, Patricia A. Dalki, discussed her views on the subject. Patricia has done the heavy lifting on researching the “How To” approach when drafting  such an agreement and has kindly shared her thoughts on the subject with me. Her research included an article by David L. Hayes of Fenwick & West LLP entitled, The Enforceability of Shrinkwrap License Agreements On-Line and Off-Line and she also cited an article I had included in my original posting mentioned above by Jason Haislmaier entitled, How Do I Build an Enforceable Online Agreement? – Not (Always) the Way SalesForce.com or Google Would.

With the kind permission of my friend and colleague, Patricia A. Dalki, here are some tips how to create an enforceable on-line agreement:

 1.  Record Evidence of User Acceptance

• Record evidence of user acceptance and the formation of each on-line agreement using a consistent, auditable process.
• By procedure – maintain evidence that the only way to access the service or product being offered is to scroll through terms and click “I accept” – user must have accepted.
• To the extent possible, keep records of time, date, and source of acceptance.

2.  Require Acceptance Before Delivery of Services or Payment

• Require acceptance before payment or delivery of the services.

3.  Make Rejection Clear and Simple

• Provide a clear, simple method for customers to reject the contract.
• Allow users to exit the process at any time.
• Do not require the customer to take additional steps or expend effort/money to reject the product or service.

4.  Make Assent Unambiguous

• Secure an affirmative, unambiguous manifestation of assent to the agreement from the customer.
• The more the customer has to do, the better.
• Examples include:

a.         Mouse click “I accept” or “I agree” button;
b.        Type “I agree” and submit (speed-bump for users, but more deliberate);
c.        “I accept” checkbox next to each provision, especially with an unusual or onerous provision; and
d.        Offer alternative “I don’t agree” option with an explanation that the user cannot use or access the product or service.

5.  Condition Use on Acceptance (covered in the introductory paragraph)

• Expressly state the user’s access to or use of the product or service is subject to these terms.
• Expressly state that you will not provide the product or service except pursuant to these terms.

6.  Provide Notice of All Terms

•  Draw attention to the on-line agreement.
•  Make sure the customer sees it, e.g. no “below the fold,” small print, or hidden text.
•  Place the “Accept” option at the end of all terms.
•  Require the user to scroll though all terms before making the acceptance action.
•  Consider requiring the user to check an “ I accept” box for each provision, especially for an unusual or onerous provision.
• No link to terms or scroll boxes
• Advise user to print and keep a copy of the agreement.

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There is an episode in Seinfeld where Jerry and Kramer are having a disagreement on an accounting issue. Kramer claims that the Post Office can just “Write Off” an insurance claim as a loss. Jerry implies that Kramer doesn’t even know what a write off is. When Kramer retorts, “Well do you?”, Jerry confidently states in a tone of honesty “No, I don’t”. That’s when Kramer comes in and seals the deal with the irrefutable line, “Well they do, and they’re the ones writing it off”.

Well, my friends, I am afraid that there is a bit of accounting “know-how” required to fully comprehend the latest opinion from Gartner analyst Robert DeSisto. As Richard Adhikari reports in his article for InternetNews.com entitled Gartner Warns on SaaS’s Hidden Costs, the Total Cost of Ownership (“TCO”) may be great for the first 2 years since SaaS does not require an initial capital outlay for hardware and the licensing model is pay-as-you-go. However the accounting for on-premises applications flips this advantage since the large capital outlay eschewed by SaaS proponents comes into play in later years. You see the larger expense for infrastructure in the non-SaaS model can be capitalized and any self-respecting accountant will tell you that means this “Capitalized Expense” can be depreciated. In essence the depreciation expense becomes a “Write-Off” against revenues. Oh dear, if I have confused you either see Kramer’s explanation above (or) the September 29, 2008 posting in this Blog, SaaS Contracting: Tips Leading to the Decision and What to Include in the Agreement.

Adhikari includes a rebuttal to DeSisto’s capital expense argument from Raju Vegesna. Vegesna comes back with the fact that SaaS pricing includes maintenance, support, and upgrades. Other SaaS proponents tout the ease of implementation and the favorable pricing model. On the flip side, DeSisto cautions that enterprises requiring tight integration with existing systems might not have the quick roll-out as promised. In addition, although the SaaS pricing model is advertised as a pay for the computing resources used, a significant number of SaaS Vendors have opted for other pricing models. In particular, DeSisto points to Salesforce.com whose pricing requires the customer to purchase subscriptions for a period of time regardless of use. 

I think the jury may still be out on this one. What isn’t discussed at length in this article, but is only hinted at, is the fact that the SaaS model should be attractive to the smaller enterprise and/or the start-up, while the larger enterprises might well be served with the traditional on-premises model.

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The business environment for 2009 looks bleak.  Financing came to a screeching halt in the late summer of 2008 and capital markets are still reticent on extending credit.  What is an enterprise to do?  As Bryan Stolle, partner with Mohr Davidow, points out in his article How to Survive - and Thrive, the key is first to survive by assessing the environment, creating a plan, and executing.  Once the economic recovery begins, your company must have differentiated itself from the other companies in its market-space.   

Stolle presents a list of 10 tips for the tech CEO of today.  As he states, some are obvious.  I will try to summarize his action plan below, but for the full impact I strongly suggest you read his article:

1.       Question every expenditure:  If it does not fit into the “Must Have” category, then it should be cut.  Does the spend positively affect the bottom line?  Examine R&D with an emphasis on return on investment and its ability to differentiate your products from your competitors.

2.       Everyone is a salesman:  All employees must focus on acquiring new customers and maintaining the current customer base.  All top executives, CEO included, need to be in the field or on the phones.

3.       Mirror your customer’s mantra – cut costs:  Your sales pitch must state how much your solution will “CUT COSTS”.  Your customers won’t be listening to anything else.

4.       Increase your marketing efforts:  The more spent in this area will help your customers to focus their spend prioritizing on your application, the sales process is enhanced, and competitors will be forced to compete or leave the market.

5.       Refocus your distribution strategy:  The search for new channel partners and resellers is a drain on cash.  Funnel your cash into the proven channels and leave the marginal producers for later.

6.       Cut headcount – but do it fairly:  In my career I have seen enough of the “Trim the Fat” executives as it relates to personnel and I know the devastating affects it has on the individual, on his/her family, and on company morale.  Stolle also recognizes the need to maintain and “nurture the esprit de corps - not kill it” and advises to give full consideration to the corporate culture.

7.       A good time to hire:  As a counter-balance to point 6 above, this may be the time to upgrade your team.  Top-performers in other companies may be getting a bit nervous with their current position in light of the current economic climate.  If offered the right package, these top performers would be happy to join your team.

8.       Reexamine the operation and consider a new approach:  Take this opportunity to rethink how the company works.  Perhaps an outside observer can suggest a new approach and re-energize the operation.

9.       We are a global economy: Since the internet and global supply chains and global service providers allow us to sell our products and services anywhere in the world, then take advantage of this fact.  Stolle suggest that you find a market that is healthier than the US and Europe and determine if you can sell at or below our current market costs.  If so, then do so.

10.   Reject the urge to merge:  In the current economy, the chances are both companies will fail.  Two struggling companies seldom create one strong enterprise.

Stolle’s concluding remarks are right on point and I couldn’t say them better.  He concludes by saying:

“Whether all, or just some, of the above apply to you, to make it through these “interesting times”, you must a) be very sober and realistic about valuations if you must raise capital, b) treat every dollar as if it’s your last to avoid having to raise more capital, and c) lead, lead, lead!

Lead with a vision of how your company will be a winner despite the tough times; lead with a plan that will deliver on that vision and is credible and inspires trust and confidence; lead with execution from the front (as in constantly in front of customers and employees), hammering the vision, the plan for success, and the results.”

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Due to the differences between traditional “on premise” software licensing and the newer software as a service (“SaaS”) offering, there were bound to be required adjustments on how the software customer contracted for these services.  We owe a debt of gratitude to Gene Landy with the law firm of Ruberto, Israel & Weiner, P.C. in Boston, MA.   Landy has put together a list of 8 items in his article 8 Legal Tips for SaaS Vendors that should be considered by the SaaS Vendor while developing their SaaS offering.  Including some or all of these tips in your contract may be a smart decision.  Here is a brief summary of those legal tips:

1.     Look for restrictions in your own software licenses:  As you develop your offering, do your licenses prohibit use as a service bureau or are there restrictions on remote access or use as an Application Service Provider.  You wouldn’t want your SaaS application to be in violation of any of these restrictions.

2.     Has your contract model evolved:  Initially the SaaS offering came in a 2 part form - first a software license and then a hosting agreement.  Today the more common contract model is to view this as a subscription and not mention licensing in the agreement.

3.     The Tax Man:  Your customers may be interested to know that most states do not levy a tax on services as they do for the sale of a license.

4.     Trials:  The SaaS Vendor could include a trial period bundled into the subscription agreement.

5.     Required upgrades limit the SaaS vendor’s maintenance costs:  Require customers to upgrade and eliminate having to maintain prior releases.

6.     Security:  It is fine to tout your security measures, but never promise 100% guaranteed data protection.  This is IT after all and you are using the internet.

7.     Consider SAS 70 as a selling feature:  You can provide your customers with an extra level of comfort and some of your customers may actually require a SAS 70 certification.  This is a certification performed by an outside accounting firm which attests to the accuracy and security a vendor provides.  The certification states that the controls are adequate.

8.     Data Breach Notification:  In the event of a data breach most states require a notification be sent out to the subjects of such a breach.  Make sure that your customers do not attempt to place such obligation upon you.  The costs could be prohibitive.

This is by no means an inclusive list, but Landy has hit some key issues. I found it very informative and helpful.

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There are many items to consider before deciding to adopt a SaaS approach to your IT operation.  Marcia Gulesian, a software developer, project manager, CTO, CIO, and author of numerous feature articles on IT, has captured the salient points in her article SaaS: Financial, Legal & Negotiation Issues.  As the title to her article suggests, the financial implications should be addressed first.  Gulesian has a very descriptive section on the differences between buying the software application and leasing it.  She discusses the differences of owning an asset and its tax advantages of the deductibility of depreciation as opposed to the leasing option.  There is a brief explanation of cash flows between the two alternatives, finding your opportunity cost, and making your determination on the comparison of the present values of the cash flows from the cost of owning versus the cash flows from the cost of leasing.  Before we go too far afield, my readers can attest to the fact that I always try to define our terms before delving into the nuances that the subject line suggests.

Wikipedia’s definition of SaaS is very complete yet succinct:

“Short for Software as a Service, SaaS is a software delivery method that provides access to software and its functions remotely as a Web-based service. SaaS allows organizations to access business functionality at a cost typically less than paying for licensed applications since SaaS pricing is based on a monthly fee. Also, because the software is hosted remotely, users don't need to invest in additional hardware. SaaS removes the need for organizations to handle the installation, set-up and often daily upkeep and maintenance. Software as a Service may also be referred to as simply hosted applications.”

I also have a posting in this blog, which I must admit has become quite popular based on the number of hits registered to it, entitled SaaS is the Future.  In it I discuss how a Managed Service Provider (“MSP”) can help software developers get their product to the market faster since the infrastructure barriers and capital expenditures are significantly lessened.  In another posting about Unified Communications I have quoted Mat Taylor, a senior software architect with British Telecom, regarding the benefits of SaaS:

"The ability to get things done faster, get workers more engaged in a business scenario, provide better customer service, are all big productivity wins that benefit the bottom line"

In light of the above discussion surrounding “lower total cost of ownership and quicker time-to-value”, Gulesian cautions us that the other factors to include in the financial calculation is the maintenance and support fees that come with ownership as compared to the SaaS fees which includes these items.

SO WHAT DO I INCLUDE IN THE SAAS CONTRACT?

Gulesian points out three areas that must be addressed in the contract:

·         Integration with your non-SaaS systems

·         Loss of control of data

·         Dependence on the provider for security

The CIO and his or her team are the main players to address the integration issue.  Although the next two points also require the IT organization’s participation and input, these are matters that must be addressed upfront in the agreement itself.

Risk of loss of your data is paramount.  In the event that the SaaS provider is unable to provide the support anticipated, it is essential that you have access to the applications as well as your proprietary data.  Inability of the provider to provide support may happen for a myriad of reasons such as bankruptcy of the provider or a real or threatened patent infringement claim and subsequent injunction.  The preferred approach to protect against such loss is to insist that the provider place its code into an ESCROW account.  Language can be drafted which will instruct the trustee  of the escrow ( an independent and trusted third party) to release the code to the beneficiary (i.e. you) upon the happening of certain events which are defined in the escrow language in your SaaS agreement.  One shortcoming to this occurrence is the downtime that may be involved in getting your systems up and running, but this is a necessary protection that you must include in your contract.

Transition assistance is another item to consider.  In the future you may wish to change the SaaS application currently in use.  Language should be included to require the provider’s assistance in developing the data migration strategies and the procedures to be followed so you can move your data to another application.

Since the SaaS model is economical by nature (see Wikipedia definition above), traditional discounting expectations are not available.  Pricing is based on users or seats.  The more users subscribed, the more likely the cost per user can be discounted.  So plan accordingly and try to build in volume discounting per blocks of users.

Other items Gulesian notes for inclusion in the agreement are:

·         Service Level Agreements (SLAs) regarding

§  Availability

§  Response times

§  Notifications of outages

·         Regulatory compliance

·         Data integrity

·         Data Privacy

·         Frequency of backups

·         Disaster Recovery

Gulesian’s article hits the main points and I highly recommend it to my readers.

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Shashikant Chaudhary is the current Vice President of GlobalLogic (formerly known as IndusLogic).  He recounts his journey from founder of Lambent Technologies, a provider of mobile solutions, through his trials and tribulations as the company grew, to the eventual sale of his company in an opinion article in SandHill.com entitled Growing a Software Company on a Shoestring.   Along the way he developed what he considers the 4 most important points that any software entrepreneur should keep in mind on his/her way to financial success.  Isn’t this everyone’s dream?  Doesn’t everyone wish they could start a software business, watch as it builds to a crescendo and then sell it on the upswing?  Bet you thought all you’d have to do is read this posting, take note of a few tips and/or tricks, and soon you would be rolling in the money faster than you could count it.  Well they are no guarantees in life.  In fact I have this Blog loaded with disclaimers, but let me add just one more: the 4 tips included in this posting do not guarantee success.  These tips are merely a recounting of how one person did in fact start a company and helped it grow and then eventually cashed out.  I do admit that his story is quite compelling and his “Tips” although not groundbreaking theory, do provide any interesting twist to some age old formulas.  When writing this posting for this Blog I wasn’t quite sure which category to place it in because it is only tangentially related to software licensing and outsourcing.  The story of the business discussed and how it grew and was eventually sold has an element of Telecom, but I decided that it is most likely best considered as “Other Interesting Items” and so that is how this posting wound up here.

I like that Chaudhary starts off in his article by identifying the stakeholders in his business as the employees, investors, and customers.  Too many times business people center their efforts on the investors (usually shareholders in a publicly traded company) and relegate the employees to a second tier.  Customers are sometimes not even considered stakeholders.  They occupy some other category maybe on a par with stakeholders, but not quite the same.

Chaudhary wastes no time and dives right in with his 4 key success factors for the software services entrepreneur.  These 4 key success factors are:

·         Talent:  Putting together the right team is essential

·         Employee Loyalty:  One must be able to keep the talent.  Chaudhary used an innovative stock plan to keep his employees loyal.

·         Find your niche:  As a small company Chaudhary took some inspiration from Al Ries and Jack Trout, authors of “Marketing Warfare”, and sought to attack his bigger competitors at their weak points, hence “win battles” but not the whole war.

·         The CEO or Owner must be the sales leader.  This is too important a role to be left to anyone else.

He tells an interesting story on how he identified potential customers.  He describes his strategy of face to face meetings and the absence of email or the phone as part of that strategy.  He did target seven cities in the US and visited them on a regular schedule.  The word “frugal” does not even begin to describe his approach.  His strategy worked and he identified people of influence and companies who had a need for his services.  His article concludes with a very brief discussion on the pitfalls that can lead to failure.  It’s not an indepth discussion on pitfalls.  Perhaps it didn’t need to be since his company was merged long before any of the pitfalls he identifies had time to get a foothold.

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This post is aimed specifically at the SMB enterprise and those consulting such enterprises. Recently in a post to this blog on February 3, 2008, I posted an article detailing a checklist for those enterprises that have already faced the questions on whether to outsource or not entitled Checklist Before Outsourcing Your IT.  That article has attracted a large number of readers.  In the article that follows I hope to aid those SMB’s that are still grappling with the decision on whether such a move is in their best interest.  In my research I have found an article written by Rojo Sunsen entitled 10 Ways Outsourcing Can Help Grow Your Business.  Sunsen succinctly defines outsourcing and then follows this definition with a rather direct and to the point list on the benefits to the enterprise.  I have paraphrased Sunsen’s list below; however I highly recommend the complete article in order to gain the fuller picture and what such a move can do to grow your business.

1. Employee training is reduced and allows such time to be directed to the company’s core competencies.

2. Capital outlays for equipment and software are reduced and can be placed into more revenue generating endeavors.

3. Save on the expenditure of employee recruitment to fill positions for intra-company administrative functions.

4. Hand-in hand with point #3 above is the time that is saved performing certain administrative tasks that are ancillary to the enterprises core functions.

5. Yet another savings to points #3 and #4 above are the employee benefits costs that are no longer required such as “taxes, medical, vacation time, holidays, worker’s comp., unemployment costs, etc.”

6. Office space opens up which could be better used performing the tasks required on the revenue side of the business; or alternatively, space could be sublet or a company’s leasing requirements can be reduced.

7. Order processing and delivery of products or services can be enhanced thus creating better customer satisfaction which can result in future return business.

8. More emphasis can be placed on increasing market share with the abovementioned improvements and savings.

9. In line with point #8 above is the ability to accept larger orders or take on more orders due to the economies of scale which should come about due to the outsourcing.

10. Lastly, your outsourcer can become a valuable ally in your marketing efforts and provide an additional outlet and/or network of customers.

Implicit in the above savings tips is the ability to redirect funds usually budgeted for the administrative side of the business and put these monies to better use on the revenue generating side of the P&L.

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